TY - JOUR
AU - Durdu,Ceyhun Bora
AU - Mendoza,Enrique G.
AU - Terrones,Marco E.
TI - Precautionary Demand for Foreign Assets in Sudden Stop Economies: An Assessment of the New Merchantilism
JF - National Bureau of Economic Research Working Paper Series
VL - No. 13123
PY - 2007
Y2 - May 2007
DO - 10.3386/w13123
UR - http://www.nber.org/papers/w13123
L1 - http://www.nber.org/papers/w13123.pdf
N1 - Author contact info:
Ceyhun Bora Durdu
Federal Reserve Board
20th Street and Constitution Avenue N.W.
Washington, DC 20551
E-Mail: bora.durdu@frb.gov
Enrique G. Mendoza
Department of Economics
University of Pennsylvania
3718 Locust Walk
Philadelphia, PA 19104
Tel: 215-898-7701
E-Mail: egme@sas.upenn.edu
Marco E. Terrones
Research Department
International Monetary Fund
700 19th Street, N.W.
Washington DC 20431
E-Mail: mterrones@imf.org
AB - Financial globalization was off to a rocky start in emerging economies hit by Sudden Stops since the mid 1990s. Foreign reserves grew very rapidly during this period, and hence it is often argued that we live in the era of a New Merchantilism in which large stocks of reserves are a war-chest for defense against Sudden Stops. We conduct a quantitative assessment of this argument using a stochastic intertemporal equilibrium framework with incomplete asset markets in which precautionary saving affects foreign assets via three mechanisms: business cycle volatility, financial globalization, and Sudden Stop risk. In this framework, Sudden Stops are an equilibrium outcome produced by an endogenous credit constraint that triggers Irving Fisher's debt-deflation mechanism. Our results show that financial globalization and Sudden Stop risk are plausible explanations of the observed surge in reserves but business cycle volatility is not. In fact, business cycle volatility has declined in the post-globalization period. These results hold whether we use the formulation of intertemporal preferences of the Bewley-Aiyagari-Hugget class of precautionary savings models or the Uzawa-Epstein setup with endogenous time preference.
ER -